Chapter Completing the Accounting Cycle Albrecht, Stice, Stice, Swain COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation Thomson, the Star logo, and South-Western are trademarks used herein under license LEARNING OBJECTIVES • How accrual accounting allows for timely reporting and a better measure of a company’s economic performance? • Explain the need for adjusting entries and make adjusting entries for unrecorded receivables, unrecorded liabilities, prepaid expenses, and unearned revenues • Explain the preparation of the financial statements, the explanatory notes, and the audit report • Complete the closing process in the accounting cycle • Understand how all the steps in the accounting cycle fit together Foods for thought • In 2011, you sign a contract of $100,000 for writing a software The software is to be delivered in 2012 • You have received $20,000 after signing the contract, and expect $80,000 in 2012 • How much is your revenue? • When will you be able to answer the question with certainty? • Can you wait until 2012 to prepare the financial reports? • Relevancy (Updated infor) vs accuracy Periodic Reporting Beginning Year of Year End of Year • Fiscal – 12-month accounting period • Calendar Year – When an entity closes its books on December 31 Accrual Accounting • What we when transactions span more than one period? • Accrual Accounting! – Revenues and expenses are recorded as they are earned and incurred, not necessarily when cash is received or paid – Better measures a firm’s performance than does cash flow data • Can you easily estimate the profit when Honda sell a car? • the deal is not done until many years later What should be recorded as revenue now? • You sold and shipped a car but cash will be received next year • Boeing received cash from VA and will deliver planes years from now • You sold your poor friend a second hand computer for $100,000 on credit Revenue Recognition Recognize revenue when: The earning process is substantially complete Cash has either been collected or collection is reasonably assured The Matching Principle • All costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues If revenues are recognized Related costs and expenses should be recognized Situation • You are running a computer store – List major revenues and expenses – What expenses will be recognized when you sell a computer? – How about the store rent? Wages of employees? 10 21 22 23 The Notes • Notes – List assumptions and methods used in preparing the financial statements – Give more detail about specific items – Augment the summarized numerical information 24 25 What Auditors • Check financial statements for conformity with GAAP • Review Adjustments • What should the auditors be concerned? • sample selected accounts – How would you verify that the asset accounts are correct? • review accounting systems – Would you trust the financial reports prepared in an accounting system that is haphazard, with many missing documents? • Attaches audit report and distributes it with the financial statements 26 Real vs Nominal Accounts • Real Accounts – Permanent • Not closed at year end – Balance Sheet accounts – Balances are carried forward to next period • Nominal Accounts – Temporary • Closed (brought to a zero balance) at year end – Income Statement accounts and dividends – Balance are NOT carried forward to next period 27 The Closing Process • The Closing Process – Record entries that reduce all nominal accounts to a zero balance at the end of the accounting period – Nominal accounts are closed to retained earnings Revenues xxx Retained Earnings Bal xxx Beg Bal xxx Expenses Bal xxx Revenues xxx Expenses 28 Closing Entries • Step 1: Close all revenue accounts by debiting them • Step 2: Close all expense accounts by crediting them • Step 3: The difference between revenues and expenses (net income) should be credited to retained earnings Revenues XXX Cost of Goods Sold XXX Other Expenses XXX Retained Earnings XXX 29 Dividends • Nominal account but NOT an expense • Distribution to shareholders • Closed by crediting dividends and debiting retained earnings (reduces retained earnings) When dividends are first declared: Dividends XXX Dividends Payable XXX When dividends are paid: Dividends Payable XXX Cash XXX To close dividends at year end: Retained Earnings XXX Dividends XXX 30 31 Preparing a Post-Closing Trial Balance • List of all real accounts • A check of whether total debits equal total credits for all real accounts prior to beginning new accounting cycle Rodman Industries Inc Post-Closing Trial Balance December 31, 2009 Cash Accounts Receivable Inventory Supplies Accounts Payable Capital Stock Retained Earnings Totals Debits $ 8,200 4,000 3,000 1,000 $16,200 Credits Debits = Credits $ 5,000 10,000 1,200 $16,200 32 Review of the Accounting Cycle Step Step Step Step Analyze Analyze transactions transactions Record Record the theeffects effects of of the the transactions transactions Summarize Summarizethe theeffects effects of of transactions transactions 1 2 Posting Postingjournal journalentries entries Preparing Preparingaatrial trialbalance balance Prepare Preparereports reports 1 2 3 Adjusting Adjustingentries entries Preparing Preparingfinancial financialstatements statements Closing Closingthe thebooks books 33 PE4-16/161 34 35 ... Accrual-Basis Accounting Cash receipts $41 ,000 Cash disbursement 28,000 Income $13,000 Revenues earned $48 ,000 Expenses incurred 31,000 Income $17,000 11 Practice E4-25 12 Adjusting Entries • Entries... Cash-Basis Accounting During 2009, Bond Consulting billed its client for $48 ,000 On December 31, 2009, it had received $41 ,000, with the remaining $7,000 to be received in 2010 Total expenses during... balances 1,800 12/31/09 Unearned Rent 1,800 Rent Revenue 3,600 1,800 1,800 1,800 18 Practice E4-26/1 64 19 Preparing Financial Statements Four step process using the trial balance: Identify all